Lies, damn lies, and US GDP

US GDP collapsed in Q1 according to the final estimate. However, this looks like an aberration and most data suggest that the economy is going from strength to strength. Eurozone business surveys softened in June. They underline that the eurozone economy is experiencing only a moderate recovery currently, though it should gradually gain some pace. Meanwhile, the BoE took direct measures to restrain housing and mortgage lending. Such so-called macro prudential tools can take away some of the weight from monetary policy in preventing financial imbalances and therefore reduce the need for aggressive rate hikes.

The US economy contracted spectacularly in Q1 according to the final figuresNick Kounis Head of Macro Research

The peculiar case of Q1 US GDP

The US economy contracted spectacularly in Q1 according to the final figures. The first time that the Commerce Department released the numbers back in April, it estimated that the economy grew by 0.1%. At the time, economists had expected an expansion of 1.2%. In the second estimate, in May, GDP was revised down, with the economy seen to have shrank by 1%. Last week’s final estimate contained another downward revision, with GDP falling by 2.9%. What is going on? The extreme weakness in the economy probably reflects some combination of the effects of the bad weather and volatility in some components of demand, such as inventories and health care spending. These factors conspired to produce a decline in GDP, which is unheard of outside of a recessionary period.

The real US economy comes to the fore

Fortunately, most data suggest not only is the US economy nowhere near a recessionary period, but economic growth is actually going from strength to strength. This was underlined by almost every other economic release last week. Starting with the manufacturing sector, the flash Markit PMI rose to 57.5 in June from 56.4 in May. The details of the report were generally impressive, with the new orders index climbing above the 60-mark. This was the highest since May 2010. Meanwhile, consumer confidence rose to 85.2 in June from 82.2 in May, which took it to its highest level since January 2008. The positive mood of consumers reflects the acceleration in job growth and falls in the unemployment rate. In addition, household wealth has surged over recent quarters, which also makes consumers more willing to spend.

Housing and investment also turning up

These upbeat trends in surveys are also evidence in the hard data. New home sales surged in May. They grew by a tremendous 18.6% following a 3.7% rise in April. This was the biggest monthly gain since January 1992 and took sales to an annualised pace of 504K, which is the highest since May 2008. This follows strong growth in existing home sales (+4.9%) and suggests that the housing market is rebounding following the soft patch seen during the second half of last year and the early months of this year. We expect the housing market recovery to be sustained. Finally, durable goods orders were soft in May, but that followed a number of months of strong gains, so the underlying trend is very clearly upwards. For instance, the core capital goods shipments – a good proxy for business investment – grew at an annualised 8.1% rate in the 3-months to May, up from 4% in April.

Q1 drags down 2014 average, but 2015 a better picture

The weak first quarter drags down our year average GDP forecast for 2014 to 1.8% from 2.7% previously. However, this masks strength during the year, with the economy likely to see strong growth rates (in the 3-4% region) from Q2 onwards. This is better reflected in the 2015 forecast of 3.8%, which we think gives a more realistic indication about how we see the current momentum in the economy.

Eurozone business surveys ease in June

The key eurozone business surveys softened in June. The composite PMI declined to 52.8 from 53.5. The European Commission’s economic sentiment indicator slipped to 102 from 102.6, while Germany’s Ifo headed to 109.7 from 110.4. Still, the indicators remain at decent levels from a historical perspective and are still consistent with a moderate recovery for the eurozone as a whole. There is no good reason to think that June’s declines are the start of a more ominous downward trend. The global recovery should support eurozone exports, while domestic drags, such as high unemployment, are easing. Finally, the ECB’s actions to ease financial conditions and support bank lending are also a positive for growth, even though they will take time to gain traction.

Inflation close to inflection point

Eurozone inflation data have had a very clear theme recently. They have tended to head down, which has raised concerns about the risks of deflation. Recent data suggest the downward trend is starting to dissipate. German HICP inflation jumped to 1% from 0.6% in May. Meanwhile, the price indexes from the PMI surveys generally rose. Eurozone inflation looks to be close to a trough. It will likely be flattish in the second half of the year before a slow upward trend develops next year. Domestic downward pressure will be sustained from the slack in the labour market, which will keep wage growth and hence service sector inflation subdued. On the other hand, some of the global disinflationary forces are starting to abate. For instance, global manufactured goods prices edged up in the early months of this year, after having fallen sharply in 2012-2013. Together with the fall in the euro, this suggests that eurozone import prices should turn. In addition, global food prices have rebounded (see chart) and this should over time also lead to a turnaround at the retail level.

BoE acts to rein in housing market

The BoE turned last week to macro prudential policies to pre-empt excesses related to the pickup in the housing market and household debt. The Bank’s Financial Policy Committee is concerned that the recovery in the housing market has gone hand in hand with a sharp rise in the share of mortgages extended at high loan to income multiples. It has therefore proposed a limit to banks of loans extended at high loan to income multiples. There is limited experience of macro prudential policies in the US and Europe, but they have been used more intensively in Asia, with some success. The shift to macroprudential policy in the UK is good news, as if successful, it will reduce the need for a sharp tightening in monetary policy with the aim of cooling credit and house price growth. Of course, the success of the targeted policies will not remove the need for rate increases completely. The overall economy is growing above trend and unemployment is falling rapidly. So UK rates will need to go up later this year, but it looks the BoE’s targeted action should mean that the upward trajectory will be gradual.

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Nick Kounis

Head of Macro Research

Nick Kounis studied economics and finance. He advised the Ministry of Finance in the UK on international economics, public debt and IMF programmes, macroeconomic policy and the budgetary framework. At ABN AMRO Nick conducts macroeconomic research, with a focus on international economic issues.